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Context
Social responsibility has emerged as a pivotal concept in the discourse surrounding sustainability and ethical conduct. As individuals, corporations and governments become increasingly aware of their impact on the environment, the imperative to address and mitigate carbon footprints has gained significant traction.
A carbon footprint, representing the total greenhouse gas emissions that are caused directly and indirectly by an entity, has become a critical metric in assessing environmental impact. The heightened emphasis on social responsibility underscores the necessity for proactive measures to reduce these emissions, thereby contributing to the global effort to combat climate change. This collective responsibility is not just an environmental imperative but also a moral one, as the consequences of inaction affect ecosystems, economies and communities worldwide. Reducing carbon footprints thus stands at the forefront of contemporary efforts to foster a sustainable and equitable future.
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What is the Carbon Border Adjustment Mechanism ('CBAM')?
Amidst the surge of ESG awareness, the environmental imperative looms large. As the European Union ('EU') intensifies its climate commitments, the specter of carbon leakage (when carbon-heavy production relocates to regions with less stringent climate policies) emerges as a threat to its ambitious climate agenda.
On May 10, 2023, the European Parliament and the Council had established the CBAM through Regulation (EU) 2023/9561.This mechanism regulates greenhouse gas emissions embedded in specific goods upon their importation into the EU's customs territory, aiming to prevent the risk of carbon leakage.
The CBAM represents a significant effort by the EU to combat climate change by assigning a fair price to carbon emissions from the production of carbon-intensive goods imported into the EU. It seeks to ensure that the carbon costs of imports align with that of domestic production.
While supporting the climate goals for the EU, the CBAM is also anticipated to encourage decarbonization efforts in third countries. It fosters fairness by equating the carbon costs of imports with domestic production costs, thereby becoming an essential element for a sustainable future that balances environmental stewardship with economic stability.
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What are the specific requirements?
The CBAM is currently in a transitional phase (from 2023 to 2026), with its full operation expected to begin in 2026. This transition aligns with the EU Emissions Trading System's ('ETS')'s progressive elimination of free allowances - a strategy designed to accelerate the decarbonization of the EU's industry. During this phase the CBAM is focusing on sectors most at risk of carbon leakage, such as cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen. During the transitional period from October 1, 2023, to December 31, 2025, an importer's responsibilities are confined to reporting obligations. Each importer needs to submit a CBAM report for the corresponding quarter within a calendar year, detailing the imported goods and the actual total embedded emissions for each category of goods. The deadline for the first quarterly report was January 31, 2024.
The year 2026 will initiate the definitive regime for the implementation of the CBAM. EU importers of goods falling under the CBAM will be required to register with national authorities and obtain CBAM certificates. The price of these certificates will reflect the weekly average auction price of allowances from the EU's ETS. Importers will be required to report the emissions contained within their imports and surrender the appropriate number of certificates. The financial obligations of the CBAM will commence on January 1, 2026, requiring importers to register as authorized declarants and begin purchasing CBAM certificates. The initial annual declaration is due by May 31, 2027.
Should importers demonstrate that a carbon price was paid during production, they would be entitled to a deduction of that amount. The CBAM will extend to indirect emissions as well, which include emissions from electricity generation used in the production of the goods under the CBAM scope. For instance, if the manufacturing process of a product requires electricity, the emissions from generating that electricity will be factored into the CBAM calculation.
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The key takeaways
Globally, governments are implementing sustainability tax measures to combat climate change, lower emissions and advance carbon neutrality. Such measures encompass a variety of forms like tax credits, deductions, and exemptions. These incentives serve to not only alleviate the impact of climate change but also stimulate innovation and generate employment opportunities. Examples include accelerated tax depreciation and allowances, which are prevalent types of sustainable tax incentives.
Businesses should consider adopting digital solutions to strategically evaluate carbon emissions and manage associated tax incentives for long-term cost benefits. This approach aligns tax transparency with Environmental, Social, and Governance ('ESG') principles, recognizing the importance of integrating tax considerations into sustainability strategies. It could prompt organizations to prioritize ESG investments, promote responsible tax practices, and accelerate climate change mitigation and adaptation efforts, thus mitigating the impact of the CBAM on India's exports to the EU.
The CBAM represents a significant move towards harmonizing trade with climate objectives, ensuring equitable competition, and curbing global carbon emissions. For businesses, keeping abreast of the changing landscape of global sustainability tax policies is vital due to the considerable variations across different regions.
If you need further clarification, assistance or additional analysis, please do not hesitate to write to our ESG experts at contactus@mgcglobal.co.in.
Best regards
Markets Team
MGC Global Risk Advisory
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About MGC Global Risk Advisory
Recognized as one of the '10 most promising risk advisory services firms' in 2017, as the 'Company of the Year' in 2018 &, 2019 (both in the category of risk advisory services), one of the 'Top Exceptional Companies to Work For' in 2020, amongst the 'Top 25 Customer Centric Companies' in 2020, 'The Consultant of the year' in 2021 (in the category of risk advisory services), 'Top Exceptional Leaders in Risk Advisory Services' in 2023 and 'Best place to work' in 2024; MGC Global is an independent member firm of Allinial Global.
MGC Global provides services in the areas of enterprise-wide risk management, forensic, internal audits, control assessments (SOC, IFCR & SOX), process re-engineering, governance frameworks, privacy & data protection (including GDPR & DPDP), IT risk advisory, GDPR, VAPT, ISO readiness, cyber security, vCISO, accounting advisory, forensic, ESG & CSR services.
Our firm has the capabilities to service its clients through its offices in Bengaluru, Mumbai, NCR; and has service arrangements with associate firms in all major cities in India.
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About Allinial Global
Allinial Global (formerly PKF North America) is currently the world's second-largest member-based association. With collective revenues to the tune of approximately US$ 5 billion, Allinial Global has dedicated itself to the success of independent accounting and consulting firms since its founding in 1969.
It currently has member firms in over 105 countries, who have over 28,000 professional staff and over 6,000 partners operating from nearly 700 offices across the globe.
Allinial Global provides its member firms with a broad array of resources and support that benefit both its member firms and their clients in the key impact areas of learning & development, human resources, international outreach, technical support, knowledge-sharing through its specialized communities of practice, information technology and practice management.
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